Defense stocks surged higher this week ahead of and following news that the U.S. will pull out of the Iran nuclear deal. This bullish price action could mark the end of a sector correction that started after North Korea opened dialogue about lowering tensions on the Korean Peninsula. That effort has culminated in a once-unthinkable summit between President Donald Trump and Supreme Leader Kim Jong-un.
The defense sector has gained significant ground since the 2016 election, with the new president promising to increase military spending to record levels. The 2018 defense budget signed into law in December authorizes nearly $875 billion, a 7% increase over 2017, while 2019 spending is expected to rise to nearly $900 billion. That figure could go even higher as the political fallout from the busted deal makes waves around the world. (See also: The Dummies' Guide to the Iran Nuclear Deal.)
The iShares Dow Jones U.S. Aerospace & Defense Index Fund ETF (ITA) offers a convenient way to play the broad sector while generating less noise than individual equities such as The Boeing Company (BA), whose business efforts bifurcate between military and civilian objectives. The fund topped out near $126 in April 2015, following a four-year uptrend, and sold off into the mid-$80s during the mini flash crash in August of that year.
It bounced back to the prior high in June 2016 and broke out in November, entering a channeled advance that posted gains in excess of 60% into January 2018, when it topped out at $206 and dropped into a trading range with support at $184. Two breakout attempts into April failed, while a decline into early May reached range support and the 200-day exponential moving average (EMA). The ETF turned sharply higher this week and could break out before the third quarter. (For more, see: It's a Fact: Aerospace ETFs Love Trump.)
Lockheed Martin Corporation (LMT) produces missile defense systems and the F-35 fighter for U.S. and allied defense departments around the globe. The stock has posted phenomenal returns since 2013, gaining more than 400% into the January 2018 high at $363. The subsequent decline found support at $325, with three tests at that level attracting committed buyers into a failed breakout attempt in reaction to late April earnings.
The stock sold off into May, breaking two-month range support ahead of additional downside that ended at a 2.5-year trendline near $300 last week. It has surged more than 25 points in the past four sessions and is still testing new resistance in Wednesday's session. A rally or gap above $325 that continues to gain ground into the close should generate an intermediate buying signal, ahead of a rapid recovery into the $360s.
Dow component United Technologies Corporation (UTX) is awaiting final approvals for its blockbuster acquisition of Rockwell-Collins, Inc. (COL), announced in September 2017. The contractor has underperformed its defense rivals in recent years, but multiple synergies expected from the new Collins Aerospace division could lift the stock into a leadership role and generate an eventual spinoff.
A three-year trend advance topped out just above $120 in May 2014, giving way to a downtrend that ended at a three-year low in the mid-$80s in the first quarter of 2016. A recovery wave into July 2017 got rejected when it tested the prior high, while the subsequent consolidation completed the last leg of a multi-year cup and handle pattern that yielded a December breakout. The stock posted an all-time high at $139.24 a month later and turned sharply lower with the sector and broad market.
The decline broke 200-day EMA support and the breakout level in late April, while a bounce into this week's Iran news is generating a test at new resistance. A breakout above $125 would reinstate the cup and handle's bullish technical outlook, projecting potential upside into the $160s. A failure to penetrate that level could generate a quick plunge toward $110 while shareholders wait nervously for merger approval. (For more, see: Three Must-Own Defense Stocks.)
The Bottom Line
U.S. defense stocks may have ended multi-month corrections after President Trump pulled out of the Iran nuclear deal this week. If so, these leadership issues could head straight back to their bull market highs. (For additional reading, check out: How to Trade the Uptrend in Aerospace and Defense.)
<Disclosure: The author held shares of Lockheed Martin in a long-term family account at the time of publication.>